You are preparing a capital budget for your organization. One of the senior managers looks at your initial budget and says that it would be a lot easier to evaluate if you just use the accounting rate of return, rather than your current method of Net Present Value (NPV). Explain why you would prefer NPV to the accounting rate of return. Is there a simple ratio that you could show your manager that involves the numbers used in calculating NPV? What discount rate do we use in calculating NPV?
The net present value (NPV) method offsets the present value of an investment's cash inflows against the present value of the cash outflows. If a prospective investment has a positive net present value (i.e., the present value of cash inflows exceeds the present value of cash outflows), then it clears the minimum cost of capital and is deemed to be a suitable undertaking. On the other hand, if an investment has a negative net present value (i.e., the present ...
Response discusses the preferred use of NPV over accounting rate of return